Question 1

Which of the following support the idea that monetary policy should be made by a rule?
A)the political business cycle and the time-inconsistency problem
B)the political business cycle but not the time-inconsistency problem
C)the time-inconsistency problem,but not the political business cycle
D)neither the political business cycle nor the time-inconsistency problem

Accepted Answer

The political business cycle and the time-inconsistency problem are both reasons why monetary policy should be made by a rule. The political business cycle refers to the tendency of politicians to manipulate economic conditions to improve their chances of re-election, which can lead to unstable and unpredictable monetary policy. The time-inconsistency problem refers to the fact that policymakers may be tempted to pursue short-term goals that conflict with long-term objectives, such as maintaining low inflation. A rule-based approach can help to avoid these problems by providing clear guidelines for monetary policy that are not subject to political influence or short-term pressures.

Question 2

A 1977 amendment to the Federal Reserve Act of 1913
A)requires the Federal Reserve to place more weight on promoting price stability than on promoting maximum employment.
B)requires the Federal Reserve to place more weight on promoting maximum employment than on promoting price stability.
C)requires the Federal Reserve to place equal weight on promoting price stability and maximum employment.
D)says the Federal Reserve should promote price stability and maximum employment,but does not specify how the Federal Reserve should weight these goals.

Accepted Answer

The correct answer is D because the 1977 amendment to the Federal Reserve Act of 1913 requires the Federal Reserve to promote price stability and maximum employment, but does not specify how the Federal Reserve should weight these goals.

Question 3

A 1977 amendment to the Federal Reserve Act of 1913 says the Fed should "promote" which of the following goals?
A)only price stability
B)only maximum employment
C)only price stability and maximum employment
D)price stability,maximum employment,and moderate long-term interest rates

Accepted Answer

The 1977 amendment added the goal of "moderate long-term interest rates" to the Federal Reserve's mandate, alongside the existing goals of price stability and maximum employment. Therefore, the correct choice is D, which includes all three goals.

Question 4

The time inconsistency of policy implies that
A)what policymakers say they will do is generally what they will do,but people don't believe them because of current policy.
B)when people expect that inflation will be low,it is harder for the Fed to increase output by increasing the money supply.
C)people will believe Fed policy will be more inflationary than the Fed claims.
D)what policymakers say they will do is usually not what they do,but people believe them anyway.

Accepted Answer

Time inconsistency refers to the tendency of policymakers to deviate from their previously announced policy plans, leading people to expect more inflationary policies than what is claimed.

Question 5

According to the political business cycle theory,if the Fed wanted to see a President re-elected,prior to the election it might
A)buy bonds to raise interest rates.
B)buy bonds to reduce interest rates.
C)sell bonds to raise interest rates.
D)sell bonds to reduce interest rates.

Accepted Answer

According to the political business cycle theory, the Fed might buy bonds to reduce interest rates, which can stimulate the economy and improve the incumbent President's chances of re-election by creating a more favorable economic environment.

Question 6

The time inconsistency of monetary policy means that
A)once people have formed expectations of low inflation based on a promise by the central bank,the central bank is tempted to raise inflation to lower unemployment.
B)at some times central banks think it is more important to keep unemployment low;at other times,they think it is more important to keep inflation low.
C)monetary policy is not consistent across time because it is influenced by politics.
D)monetary policy is not consistent across time because policymakers are incompetent.

Accepted Answer

The time inconsistency of monetary policy refers to the tendency of policymakers to deviate from their announced policy when the actual economic conditions change. For example, if the central bank promises to maintain low inflation, but then the economy experiences high unemployment, the central bank may be tempted to raise inflation to lower unemployment. This results in the loss of credibility of the central bank's policy, as people will now expect higher inflation in the future.

Question 7

A 1977 amendment to the Federal Reserve Act of 1913
A)says the Federal Reserve should only promote maximum employment
B)says the Federal Reserve should only promote price stability
C)says the Federal Reserve should promote price stability and maximum employment,but does not specify how the Federal Reserve should weight these goals.
D)says the Federal Reserve should promote price stability and maximum employment,but specifies that it place more weight on promoting price stability.

Accepted Answer

The answer of A 1977 amendment to the Federal Reserve...

Question 8

According to the political business cycle theory,if the Fed wanted to see a President re-elected,prior to the election it might
A)lower the discount rate and sell bonds.
B)lower the discount rate and buy bonds.
C)raise the discount rate and sell bonds.
D)raise the discount rate and buy bonds.

Accepted Answer

According to the political business cycle theory, if the Fed wanted to see a President re-elected, it might lower the discount rate and buy bonds. By lowering the discount rate, it becomes easier for banks to borrow money, leading to an increase in money supply and economic activity. Buying bonds increases the money supply as well and lowers interest rates, leading to overall economic expansion and potentially boosting the re-election chances of the incumbent President.

Question 9

The Federal Open Market Committee
A)by law must focus on maintaining low inflation rather than stabilizing output.
B)by law must focus on stabilizing output rather than maintaining low inflation.
C)by law must follow a mechanical rule that takes into account deviations of unemployment from its natural rate and deviations of inflation from a target.
D)operates with almost complete discretion over monetary policy.

Accepted Answer

The Federal Open Market Committee (FOMC) operates with a high degree of discretion over monetary policy, allowing it to respond to changing economic conditions. There is no specific law mandating it to follow a mechanical rule or to prioritize either low inflation or output stabilization exclusively.

Question 10

The political business cycle refers to
A)the fact that about every four years some politician advocates greater government control of the Fed.
B)the potential for a central bank to increase the money supply and therefore real GDP to help the incumbent get re-elected.
C)the part of the business cycle caused by the reluctance of politicians to smooth the business cycle.
D)changes in output created by the monetary rule the Fed must follow.

Accepted Answer

The political business cycle refers to the theory that politicians manipulate economic policies to stimulate the economy in order to enhance their chances of re-election. Specifically, the central bank may increase the money supply and lower interest rates to boost economic growth and employment, which leads to a reduction in unemployment and an increase in real GDP, helping the incumbent get re-elected.

Question 11

If there is a political business cycle and the Federal Reserve supports the incumbent,then we should expect that prior to elections
A)interest rates and output would rise.
B)interest rates would rise and output would fall.
C)interest rates would fall and output would rise.
D)interest rates and output would fall.

Accepted Answer

If the Federal Reserve supports the incumbent, it may lower interest rates to stimulate the economy, leading to increased output before elections.

Question 12

The time inconsistency of policy implies that
A)what policymakers say they will do is generally what they will do,but people don't believe them because of current policy.
B)when people expect that inflation will be low,it is easier for the Fed to increase output by increasing the money supply.
C)people will believe Fed policy will be less inflationary than the Fed claims.
D)what policymakers say they will do is usually not what they do,but people believe them anyway.

Accepted Answer

The time inconsistency of policy refers to the fact that policymakers may promise to implement a certain policy, but then change their minds when the time comes to actually implement it. This can lead to distrust among the public and affect the effectiveness of the policy. Choice B is correct because if people expect low inflation, the Fed may be more likely to increase output by increasing the money supply, which could lead to higher inflation in the long run. Choices A, C, and D are incorrect.

Question 13

The Federal Open Market Committee meets about
A)every six days.
B)every six weeks.
C)every six months.
D)every sixteen months.

Accepted Answer

The Federal Open Market Committee meets approximately every six weeks, or eight times per year, to discuss monetary policy and make decisions on interest rates and other economic issues. This schedule may vary depending on economic conditions and other factors.

Question 14

When the Federal Open Market Committee meets it
A)looks only at the state of economy to determine how to conduct monetary operations in order to follow the monetary policy rule set by law.
B)looks at the state of the economy and economic forecasts to determine how to conduct monetary operations in order to follow the monetary policy rule set by law.
C)looks only at the state of the economy to determine the target it will set for the federal funds rate.
D)looks at the state of the economy and economic forecasts to determine the target it will set for the federal funds rate.

Accepted Answer

The Federal Open Market Committee (FOMC) looks at the state of the economy and economic forecasts to determine the target it will set for the federal funds rate. This is because the FOMC's goal is to use monetary policy to achieve its dual mandate of maximum employment and price stability. To do this, the FOMC takes into consideration a wide array of economic data to assess the current state of the economy and make informed decisions on how to conduct monetary operations, including setting the federal funds rate target.

Question 15

The Federal Open Market Committee
A)must submit its policies to the President and Senate for approval.
B)operates with almost complete discretion over monetary policy.
C)is required to target short-term interest rates in a mechanical way based on an equation that takes into account both price stability and output fluctuations.
D)is required to set and publicize targets for money supply growth.

Accepted Answer

The Federal Open Market Committee (FOMC) operates with almost complete discretion over monetary policy. While it does take into account various economic factors such as price stability and output fluctuations, it is not required to target short-term interest rates in a mechanical way or set specific targets for money supply growth. However, it must report regularly to Congress on its actions and explain the reasoning behind its decisions.

Question 16

If a government managed to reduce the time inconsistency problem by mandating that the central bank target inflation at a low rate,then
A)the long-run Phillips curve would shift right.
B)the long-run Phillips curve would shift left.
C)the short-run Phillips curve would shift up.
D)the short-run Phillips curve would shift down.

Accepted Answer

Mandating a low inflation target reduces inflation expectations, which can shift the short-run Phillips curve down as firms and workers adjust their expectations accordingly.

Question 17

The Federal Open Market Committee
A)operates with almost complete discretion over monetary policy.
B)is required to increase the money supply by a given growth rate each year.
C)is required to keep short-term interest rates within a range set by Congress.
D)is required by its charter to change the money supply using a complex formula that concerns the tradeoff between inflation and unemployment.

Accepted Answer

The Federal Open Market Committee, as a part of the Federal Reserve System, operates with almost complete discretion over monetary policy. It can adjust interest rates, buy or sell government securities, and make other moves that affect the money supply and overall economy. However, it does have to follow the general goals set by Congress, such as promoting full employment and stable prices, and report its actions to Congress. But it does not have specific numerical targets or formulas to follow.

Question 18

If there is a political business cycle and the Federal Reserve supports the incumbent,then we should expect that prior to elections the Fed would
A)raise interest rates to shift aggregate demand left.
B)raise interest rates to shift aggregate demand right.
C)reduce interest rates to shift aggregate demand left.
D)reduce interest rates to shift aggregate demand right.

Accepted Answer

If there is a political business cycle and the Federal Reserve supports the incumbent, then the Fed would try to stimulate the economy before the election to increase the chances of the incumbent being reelected. To achieve this, the Fed would reduce interest rates to shift aggregate demand right, which would stimulate the economy and increase output and employment levels. This would create a favorable economic climate for the incumbent and increase the chances of their reelection.

Question 19

Edward Prescott and Finn Kydland won the Nobel Prize in Economics in 2004.One of their contributions was to argue that if a central bank could convince people to expect zero inflation,then the Fed would be tempted to raise output by increasing inflation.This possibility is known as
A)inflation targeting.
B)the monetary policy reaction lag.
C)the time inconsistency of policy.
D)the sacrifice ratio dilemma.

Accepted Answer

Prescott and Kydland's work showed that the Fed's policy decisions may be time inconsistent since they might be tempted to deviate from their chosen policy once people's expectations have adjusted to it. Therefore, the correct choice is C, the time inconsistency of policy.

Question 20

Time inconsistency will cause the
A)short-run Phillips curve to be higher than otherwise.
B)short-run Phillips curve to be lower the otherwise.
C)long-run Phillips curve to be farther to the right than otherwise.
D)long-run Phillips curve to be farther left than otherwise.

Accepted Answer

Time inconsistency refers to a situation where future policy decisions deviate from the previously announced commitments. In the context of monetary policy, this means that a central bank may announce a low inflation target but later deviate from it due to political pressures or short-term goals. This inconsistency leads to higher inflation expectations and thus, a higher short-run Phillips curve. In other words, the short-run trade-off between inflation and unemployment worsens due to time inconsistency. Therefore, option A is the correct choice.

Quiz 23: Six Debates Over Macroeconomic Policy: Should Monetary Policy Be Made by Rule Rather Than by Discretion

Which of the following support the idea that monetary policy should be made by a rule?

A 1977 amendment to the Federal Reserve Act of 1913

A 1977 amendment to the Federal Reserve Act of 1913 says the Fed should "promote" which of the following goals?

The time inconsistency of policy implies that

According to the political business cycle theory,if the Fed wanted to see a President re-elected,prior to the election it might

The time inconsistency of monetary policy means that

A 1977 amendment to the Federal Reserve Act of 1913

According to the political business cycle theory,if the Fed wanted to see a President re-elected,prior to the election it might

The Federal Open Market Committee

The political business cycle refers to

If there is a political business cycle and the Federal Reserve supports the incumbent,then we should expect that prior to elections

The time inconsistency of policy implies that

The Federal Open Market Committee meets about

When the Federal Open Market Committee meets it

The Federal Open Market Committee

If a government managed to reduce the time inconsistency problem by mandating that the central bank target inflation at a low rate,then

The Federal Open Market Committee

If there is a political business cycle and the Federal Reserve supports the incumbent,then we should expect that prior to elections the Fed would

Edward Prescott and Finn Kydland won the Nobel Prize in Economics in 2004.One of their contributions was to argue that if a central bank could convince people to expect zero inflation,then the Fed would be tempted to raise output by increasing inflation.This possibility is known as

Time inconsistency will cause the